Quarterly capitalism — a system that drives far too many CEOs, directors, investors and analysts to focus on short-term performance and return on investment — is on a collision course with reality. In the risk/ reward equation that fundamentally drives capitalism, the majority is heedless to the long-term risks of climate change, water scarcity and other game-changing environmental and social threats that will also be financial game-changers for the global economy.
A research paper from London-based Generation Investment Management LP, “Sustainable Capitalism,” has some alarming news about just how short-sighted this quarterly capitalism can be.
A group of top asset managers attending a conference sponsored by Morgan Stanley (MS) were asked about their investment time horizon. Fifty-five percent said a quarter or less; only 20% said more than a year. Another survey revealed that 78% of managers would reject a net-present-value-positive project if it would lower quarterly earnings below consensus expectations, and 80% would focus on this short-term metric at the expense of building long-term shareholder value.
This should send shivers down the spine of every investor looking for long-term value creation, because climate risks alone could cost investment funds $8 trillion by 2030, according to Mercer.
But it's not hard to see why this short-termism is so pervasive. Average CEO tenure has dropped to four years from eight over the past generation, giving CEOs incentives to manage for the near term and to avoid decisions that might make long-term sense even though they don't immediately improve the bottom line.
For example, managing the long-term risks of climate change might require near-term investments and commitments to new technologies, new personnel and new risk assessment tools that a CEO might just as soon leave to his or her successor. But most compensation packages are linked not to long-term value creation and skillful management of long-term risks, but to quarterly or annual bottom-line performance. Investors, too, demand quarterly performance and generally fail to examine how companies are preparing to manage climate and other environmental risks, or even to exploit promising opportunities in clean energy innovation that are our best defense against catastrophic climate change impacts.
The good news is that there is a growing consensus among corporate leaders and institutional investors that today's major sustainability challenges — such as climate change and water scarcity — present major risks and opportunities for businesses, and that managing those risks and seizing those opportunities will be a key to success in the 21st century economy.
As we outline in the Ceres Roadmap for Sustainability — a process to help companies make the shift to sustainable business strategies — such success will require that boards of directors of both companies and large institutional investors, who owe a fiduciary duty to their shareholders and beneficiaries, become the agents of long-term value creation. It means CEOs and top management must educate themselves about these risks and opportunities and put their companies in a position to adapt and succeed in a world of growing environmental and other sustainability risks.
Generation Management recommends doing away with quarterly earnings guidance as one step toward fostering long-term thinking; General Electric Co. and Unilever are among the 20% of public companies that already have done so. After all, would anyone want to invest in a company that isn't planning or investing for beyond the next quarter?
In reality, although they might not be looking at climate and other sustainability risks, most companies have strategic plans or research and development investments that look many years down the road. GE, for example, has seen huge value in long-term R&D for its ecomagination unit, which is growing at twice the rate of the rest of the company and already has earned $85 billion of revenue.
The appropriate time horizon might vary from company to company, but at the very least, quarterly earnings guidance ought to be accompanied by three-, five- or perhaps even 10-year guidance.
Many will complain that there are far too many unknowns to make such long-range guidance feasible, that it's like trying to predict the weather years out. But that's precisely the point: Weather and climate risks caused by global warming are already upon us and will accelerate over the next decade.
Earnings guidance that looks years ahead would encourage companies that aren't doing so to look seriously at how climate and other sustainability risks might affect the bottom line. Every player in the entire investment value chain — corporations, institutional investors, policy makers, financial and equity analysts, market makers, regulators, advisers, asset managers and the financial media — should be looking further down the tracks or risk being run over by the train. n
Mindy Lubber is president of Boston-based Ceres, a coalition of investors and environmental groups working with companies to address sustainability challenges.